ACCT 1201 Lecture Notes - Dow Jones Industrial Average, Fortune Global 500, Online Banking

53 views3 pages

turquoisecrab367

5 Feb 2014

School

Northeastern University

Department

Accounting

Course

ACCT 1201

Professor

Osborne Jackson

For unlimited access to Class Notes, a Class+ subscription is required.

Document Summary

Bank of america is one of the world"s largest financial institutions, serving individual consumers, small and middle market businesses and large corporations with a full range of banking, investing, asset management and other financial and risk-management products and services. Bank of america offers services to more than 4 million small business owners through a suite of innovative, easy-to-use online products and services. The company serves clients in more than 150 countries and has relationships with 99 percent of the. U. s. fortune 500 companies and 83 percent of the fortune global 500. Bank of america corporation stock (nyse: bac) is a component of the dow jones industrial average and is listed on the new york. In late-2008, bank of america acquired merrill lynch, a long-standing, global investments and financial services firm. Even if you are not a bank of america customer, you have used some bank"s atm system and/or online banking services.

Related Questions

GIVEN:

ENRON Scandal Issues:

Auditing and Accounting Issues

Creates a new oversight board to regulate independent auditors of publicly traded companies â a private sector entity operating under the oversight of the Securities and Exchange Commission;

Raises standards of auditor independence by prohibiting auditors from providing certain consulting services to their audit clients and requiring preapproval by the clientâs board of directors for other non audit services;

Requires top corporate management and audit committees to assume more direct responsibility for the accuracy of financial statements;

Enhances disclosure requirements for certain transactions, such as stock sales by corporate insiders, transactions with unconsolidated subsidiaries, and other significant events that may require âreal-timeâ disclosure;

Directs the SEC to adopt rules to prevent conflicts of interest that affect the objectivity of stock analysts;

Authorizes $776 million for the SEC in FY 2003 (versus $469 million in the Administrationâs budget request) and requires the SEC to review corporate financial reports more frequently; and

Establishes and/or increases criminal penalties for a variety of offenses related to securities fraud, including misleading an auditor, mail and wire fraud, and destruction of records.

Pension Issues

Like many companies, Enron sponsors a retirement plan â a â401(k)â â for its employees to which they can contribute a portion of their pay on a tax-deferred basis. As of December 31, 2000, 62% of the assets held in the corporationâs 401(k) retirement plan consisted of Enron stock. Many individual Enron employees held even larger percentages of Enron stock in their 401(k) accounts. Shares of Enron, which in January 2001 traded for more than $80/share, were worth less than 70 cents in January 2002. Many employeesâ retirement accounts were wiped out. The losses suffered by participants in the Enron Corporationâs 401(k) plan have prompted questions about the laws and regulations that govern these plans.CRS-5

Securities Analyst Issues

Securities analysts employed by investment banks provide research and make âbuy,ââsell,â or âholdâ recommendations. These recommendations are widely circulated and are relied upon by many public investors. Analyst support was crucial to Enron because it required constant infusions of funds from the financial markets. On November 29,2001, after Enronâs stock had fallen 99% from its high, and after rating agencies had downgraded its debt to âjunk bondâ status, only two of 11 major firm analysts rated itsstock a âsell.â Was analyst objectivity â towards Enron and other firms â compromised by pressure to avoid alienating investment banking clients?

Banking Issues

One part of the fallout from Enron's demise involves its relations with banks. Prominent banking companies, notably Citigroup and J.P. Morgan Chase, were involved in both the investment banking (securities) and the commercial banking (lending and deposit) businesses with Enron, and have suffered from Enron's collapse. The two activities had been separated by the 1933 Glass-Steagall Act, until P.L. 106-102 (the Gramm-Leach-Bliley Act) allowed their recombination. Observers have begun to question whether that 1999 repeal of Glass-Steagall en courage conflicts of interest and unsafe bank lending in support of the investment banking business with Enron.

QUESTION: what laws (official names) are involved throughout this scandal? (through a business law standpoint)

goldshark343

UNETHICAL BEHAVIOR BY A STAR EMPLOYEE

Background

It had been another long and sleepless night, not at all whatRobbie expected when he became chief executive officer of the banktwo years ago. His wife, Beth, had noticed that something seemed tobe bothering him. "What is it, honey?"

"I was thinking about how good life was a couple of years ago,"Robbie answered. "I was the CEO of a small, local, financialinstitution with seven offices and about fifty employees. Assetswere less than $500 million. The challenging operational systems,such as asset/liability management and information technology, wereoutsourced to another bank. The truth of the matter was I didn'thave to work too hard and there were few difficult decisions. I hadplenty of time to promote myself as the successor to the retiringCEO of the much larger bank that provided the support systems to myold bank. You know what I mean, Beth. You used to be a banker."

Now Robbie was the CEO of a bank with operations in more thantwelve states, 1,000 locations and more than 4,500 employees. Only300 of these employees were at the main office. Assets were inexcess of $10 billion and growing rapidly. Robbie was responsiblefor a highly complex environment he really didn't know much about.The support of the bank's two executive vice presidents, especiallyMark, was what saved him from bad decisions, and, at the same time,caused him sleepless nights.

A Difficult Key Employee

Mark had been one of the finalists to replace the retiring CEO,having worked his way up in the financial and lending areas of thebank. Everyone agreed that his intellectual abilities were strong,as was his vision for the future direction of the bank. Mark wasalso strong willed and determined to implement his vision no matterwhat the obstacles. He had been the dominant manager in the bankbefore Robbie arrived, and continued in this role after Robbie washired.

"Why do you think Mark wasn't selected for the top job?" Bethasked. Robbie believed Mark's biggest problem was a total absenceof tact combined with a volatile temper. Mark was fond of tellingpeople how stupid they were when he was irate about something.Worse, Mark didn't distinguish between clerical employees,managers, customers or even members of the board of directors.

In addition, there was Liz, Sarah, Leslie and possibly others.Mark had sexual relationships with these employees and didn'ttrouble himself to attempt to be discreet. The affairs were carriedout during work hours, at bank functions and while travelingextensively throughout the country at bank expense. The total costwas easily in excess of six figures, all of which hit the bank'sincome statement as legitimate bank expenses.

Worse, these three employees were so inept at their assignedresponsibilities that it was clear they were being retained forsexual favors. This brought the total cost up to more than $250,000per year.

Liz was a high school graduate who had worked as a secretary ata small law firm before coming to work at the bank. She was marriedto a plumber, lived in a small town not too far from the mainoffice of the bank, and hadn't been exposed to extensive travel orexpensive hotels and meals. Her sexual relationship with Markdidn't take long to develop and it had continued for at least sixyears.

Liz's life at the bank was excellent. She was deeply fearedbecause of her relationship with Mark, and was frequently rude toother employees and managers at all levels. Liz had told Robbie offtwice since he became CEO, and neither experience had beenpleasant. She went to conferences throughout the country with Mark,which were designed for financial executives, not secretaries. Lizspent her time shopping rather than attending the programs, anyway,though. She was included in the bank's senior management bonusprogram, the only clerical employee on the list, over the protestsof many other managers. During the bank's internal educationprograms, which were usually held at resort locations, Liz wasoften at the pool, where she was easily seen by other employees ontheir way to attend training sessions.

Liz steadily progressed up the management ladder despite manygrim exit interviews with her former employees, who complainedabout the way they had been treated. Not only was she extremelyunpleasant to work for, she also lacked even basic knowledge aboutthe functional activities she managed. She reported directly toMark, who approved her travel plans and expenses as legitimate bankexpenses.

Robbie shook his head and told Beth, "Liz is a real managementproblem and an excellent example of fraudulent use of bank funds. Ireally don't know what to do about her."

"And what about Sarah?" Beth asked. Sarah was employed as asenior financial manager at the bank. She met Mark at conferencesout of town when Liz wasn't able to attend.

"Beth, let me tell you about a couple of situations involvingMark and Sarah. During a small break-out session at one conference,Sarah and Mark sat in the back of the room and talked about howdrunk they had been when they were together the night before. Theconversation was easily heard by everyone in the room. At anotherconference, Mark told the person in charge of the meeting he had toleave for the bank's main office immediately due to an emergency.Within a minute, Sarah told the same person she had an officeemergency and would be working in her hotel room for the afternoon.When the training class took a break several hours later and movedoutside to enjoy the beautiful weather, the hotel valet was justdelivering Mark's car to him. Mark laughed and said he had waitedmore than two hours for the valet to retrieve his car from thehotel garage. The employees who heard the explanation weren'tnearly as stupid as Mark thought they were. Can you imagine thishappening at the old bank, Beth?"

And then there was Leslie. She was the bank's most senior femaleofficer. She had previously had sexual relationships with both Markand William, the bank's other executive vice president, and wasthus "double-protected." She reported to William and managed thebank's public relations area. Robbie had received many complaintsabout Leslie's work, even from the bank's customers. Leslie alsohad a habit of failing to complete performance appraisals on timeor authorize the salary increases that went with the reviews. Shewas often more than a year late with these and her employees hadreached the point of mutiny. The salary increases were so faroverdue the employees' retirement contributions and 401(k) matcheswere understated. This control weakness had been reported to theaudit committee twice, and each time Robbie told them the problemhad been corrected. He knew it continued to exist, but holdingLeslie accountable would mean conflict with both Mark and William.Still, one of Leslie's employees had written a letter of complaintto one of the bank's directors and it could prove troublesome.

"I don't know how much longer I can cover for her, Beth."

"That sounds like a real mess, Robbie."

The Dilemma

Robbie started thinking about the general auditor, who had beenwith the bank for nearly ten years. The auditor had receivednothing but praise from the retiring CEO, the external auditors andthe regulators. His credibility and stature with the auditcommittee and the board of directors were excellent.

The auditor, Fred, had talked with Robbie twice about the use ofbank resources to facilitate Mark's sexual relationships. Fredpointed to bank regulations, the Financial Institutions ReformRecovery and Enforcement Act, the bank's internal policies andemployee perceptions as support for preventing the use of bankfunds to pay for sexual relationships. He also commented at lengthon the use of promotions as rewards for Liz, Sarah and Leslie inspite of their well-known lack of qualifications and ability. Thebank's clerical employees and managers believed the only reasonthese three employees remained employed was to provide sexualfavors and companionship during business travel. Fred concluded themeeting by saying, "There isn't any gray area on this one Robbie.Using bank funds and resources in this manner is plain oldfraud."

The human resources director was also highly regarded by thebank's board. Sam had talked with Robbie on several occasionsregarding complaints about the sexual relationships and theexceedingly favorable treatment extended to Liz, Sarah and Leslie.It was clear to other female employees the surest way to win apromotion wasn't through excellent job performance; it was throughsex--if you were relatively young and attractive. "I'm veryconcerned about the possible legal implications," Sam told Robbie,"as well as the example being set for our employees, to say nothingof the improper use of bank funds."

"How are you going to handle this, Robbie?" Beth asked, when hehad explained it all.

"I'm not exactly sure yet. Please listen to what I've beenthinking."

Robbie was having sleepless nights because he knew that Fred andSam were right on target in their assessments of the situation. ButRobbie also knew Mark would most likely seek other employment ifquestioned about his relationships, and without Mark, Robbie's daysas CEO might be numbered. Only Mark was capable of managing thebank to the earnings records that had been achieved recently. Markhad also been able to convince the board to greatly increasesalaries and bonuses for the CEO and two executive vicepresidents.

Mark and William were close personal friends and Robbie hadtalked with William about the situation. William reinforcedRobbie's conclusion that Mark would leave the bank if approachedabout his relationships and agreed the bank's financial resultswould not be nearly as strong without Mark. "Robbie, Mark's ego istoo strong to be dragged through the mud over these women. He'dleave for sure," William said.

Robbie told William that he had decided to ignore Mark's"personal behavior" and hope that it would soon be forgotten.

Several months later, William's new girlfriend, also an employeeat the bank, received a very poor performance appraisal. Susie wasin danger of being terminated soon unless her performance improveddramatically. William quickly transferred his secretary to anotherarea and put Susie in the position. Her new office was a few feetfrom Robbie's office and he noticed she only worked about 20 hoursper week rather than full-time. Although the bank did not allowchildren of employees in the building, Susie's three children werein her office when she was there. She used a couple of other bankemployees to help her kids with their schoolwork, and Susie spentmost of her time planning field trips and working on other schoolfunctions.

Susie and William took two hour lunch breaks together every dayand traveled together frequently. At company functions, they atefood from each other's plates in front of bank employees. Susiewielded power in William's name and became feared.

William and Susie worked late often. An hour or so after thebank closed, they would leave the bank together and get inWilliam's car. A couple of hours later, the car would return to thebank, Susie would get out and head for home in her own car. Thebank's second shift of security personnel enjoyed watching this ontheir cameras and it became widely known through the bank'sgrapevine.

Since Robbie had seemingly condoned Mark's behavior, it appearedthat William thought he had permission to become completelyindiscreet about Susie. Now more trouble was on the horizon.

Fred, the auditor, and Sam, the HR director, had agreed to giveRobbie time to end bank funding for the relationships. Robbie hadtalked with each of them twice about Mark's importance to the bank,and he asked for their patience to give him time to straightenthings out. He promised Fred and Sam they would see changes overtime implemented in such a way that no one would lose face. He didchange Liz's reporting relationship away from Mark to the chieffinancial officer. But that was the only change he had made afterseveral months.

Fred and Sam had talked with him again, but Robbie was firm inhis decision. "I don't plan any further corrective action because Ifear losing Mark. The risk of losing a star performer is too great,especially since it's simply based on personal indiscretions." BothFred and Sam were asked to cover up the situations with Mark andWilliam for the good of the bank and to ignore the regulatory,legal and policy violations. Robbie had closed the meeting bysaying he was confidant things would work out for the best, and heappreciated their support.

When Beth heard the entire sorry tale, she was worried. "Robbie,we're in trouble, aren't we?"

In your discussion comment on thefollowing:

Is Markâs behavior unethical or fraudulent?

Should Mark be terminated?

Should Leslie be terminated?

What is your opinion in regard to how Robbie handled thissituation?

Please answer only "Discussion Question" at theend.

Western States Stationery Case

Western States Stationery was founded in the late 1800s in theSan Francisco area as a one-man operation producing notepaper andcards for sale in the cityâs general stores. By 2004 it had grownto a large paper products corporation with sales more than $2billion.

One division of the company produces specialty paper products,such as writing paper, envelopes, note cards and greeting cards.Another division manufactures and prints business forms. By 2002 itwas one of the top 5 firms in the business forms industry.

For some period, the companyâs sales growth had been relativelyflat and profit margins had been difficult to maintain. Competitionamong suppliers was much more intense than in prior years. In 2002management decided it would venture into business forms inventorymanagement services. This was an area that management thoughtoffered several advantages. These services were thought to beâvalue addedâ allowing the firm to differentiate itself fromothers. Differentiation implied higher margins and the potential tofurther bind customers to Western, reducing the threat they mightswitch to an alternative supplier. Finally, the concept wasrelatively new, with little competition from large firms, therebyoffering high sales growth potential. Western embarked on acampaign to enroll its corporate clients in a program it calledTotal Forms Control (TFC).

By 2004, sales from TFC were about $60 million. Western hadestablished TFC as a separate operation within the business formsdivision. The services provided under TFC included warehousing anddistribution of forms (including inventory financing) as well asinventory control and forms usage reporting. TFC used asophisticated computer system network, which enabled them tomonitor a clientâs forms inventory, forms usage and orderingactivity.

As part of its distribution services, TFC also offeredâpick-packâ services where workers opened full cartons to pick theexact number of forms requested by the clients. TFCâs operatingphilosophy was that a well-run warehousing and distribution networkwas vital to any forms management program ---âwe know what you needâ¦ the right product at the right place at theright time.â

For a small number of clients TFC also offered "desk topdelivery," where TFC personnel would distribute the forms toindividual offices within the customerâs company (otherwise formswere usually delivered only to a receiving dock area). As acomprehensive forms management provider, Western's product linealso had to be comprehensive. Their product line includedeverything from stock computer printout paper and fax paper tocustom designed forms tailored by Western's design consultants tomeet the exact business needs of the client.

TFC also had the ability to custom design its forms managementservices to meet the needs of each of its clients. TFC clientsranged from small businesses, which desired only basic inventorycontrol, to those who had comprehensive forms managementprograms.

CURRENT COST ACCOUNTING SYSTEM

Western operated its forms manufacturing and TFC activities asseparate profit centers. Western manufactured business forms in 13locations. The transfer of product from manufacturing operations toTFC was at arm's length with the transfer price set at fair marketvalue. Although the company encouraged internal sourcing forcustomer orders, TFC salespeople had the option of outsourcingproduct.

Clients who participated in the forms management program kept aninventory of forms at one of Western's 10 distribution centers. Theforms were distributed to the client as they were needed. Theclient was charged a service fee to cover the cost of warehousingand distribution based on a percentage of the cost of sales of theproduct for that month, regardless of the specific level of serviceprovided to that client. The standard charges were as follows:

â¢ Warehousing/Distribution, 20.5% ofproduct cost

â¢ Inventory financing, 4.7% of productcost

â¢ Trucking to the customer, 7% ofproduct cost

If a TFC client made use of any of the distribution services,they were typically charged a price for the forms which was highenough to allow for an additional 20.5% of product cost to coverwarehousing and distribution expenses (everything from storage andrequisition handling up to and including desk top delivery), plus4.7% to cover the cost of capital tied up in inventory, and 7% tocover trucking costs. These percentages were determined based onactual 2002 financial data so that on an aggregate basis, in total,all expenses were covered (see Exhibit 1). Sales prices weregenerally determined by applying a 20% mark-up on the combined costof the product (business forms) and the 32.2% charge for TFCservices. To some degree, prices charged on customer accounts couldvary from the standard formula, based on what the sales departmentthought customers would pay.

UNDERSTANDING CUSTOMER PROFITABILITY

With TFC profitability suffering in October 2002, GeneralManager John Malone began to question the appropriateness of thedistribution charges: "The Business Forms Division used to earn a20% Return on Investment (ROI). But returns have been dropping forseveral years. TFC is projected to earn an ROI of only 6% for 2004.Something tells me that we are not managing this business verywell! It seems to me that the charges for services needs closerscrutiny."

John looked through his records and found two accounts ofsimilar size, accounts A and B, which were handled by differentsalespeople. Accounts A and B had essentially the same annual

sales of about $79,000 with the cost of the product being$50,000. Under the current system, these accounts carried the sameservice charges, but John noticed that these accounts were similaronly in the value of the product being sold; they were verydifferent on the level of service they required from Western.Malone double-checked his records and confirmed that the twoaccounts had indeed generated identical sales revenues (see Exhibit2).

In the past year, customer A had submitted 364 requisitions forproduct with a total of 910 lines (all of them "pick-pack") whilecustomer B had submitted 790 requisitions with a total of 2500lines (all of them "pick-pack"). Customer A kept an average of 350cartons of inventory at the distribution center while customer Bkept 700 on average. Customer B's average monthly inventory balancewas $50,000 ($7,000 of which had been sitting around for a wholeyear) while that of customer A was only $15,000. In addition,customer B had requested desk top delivery 26 times during the pastyear, while customer A did not request desk top delivery at all.John had support staff research the truck operating costsassociated with these customers. Mileage to and from each customerwas estimated and multiplied by an estimated cost per mile. Becauseof the greater activity on customer B's account, a shipment wentout three times a week at an annual trucking cost of $7,500 whileCustomer A required only one shipment a week at an annual truckingcost of $2,250.

With corporate breathing down his neck, John Malone turned toTFC Controller Melissa Dunhill and Director of Operations TimCunningham for help. As a first step, they could provide John withthe following information:

The total expenses for the distribution centers in 2002 wereestimated as follows (in 000's):

Rent	$1,504
Depreciation	$208
Utilities	$200
Salaried payroll	$945
Fringe benefitsâsalaried	$164
Taxes/Insurance	$110
Postage & supplies	$96
Hourly payroll â admin	$476
Fringes â hourly admin	$69
Variable warehouse payroll	$1,599
Warehouse fringes	$336
Total	$5,707

John said, "How am I going to use this information to solve myproblem?" "Well," Tim said, "if we can figure out, without goingoverboard of course, what exactly goes on in the distributioncenters, maybe we can take these financial numbers and assign themto the activities. If we can do that, we'll have a much better ideaof what it costs to serve our various clients." Tim knew that twoprimary activities took place in the distribution centers â thewarehousing of forms and the distribution of those forms inresponse to a customer requisition. He decided to talk to somepeople in the field to get more specific information.

DISTRIBUTION CENTER: ACTIVITY ANALYSIS

John and Tim visited Western's Kansas City, MO distributionfacility. Site manager Wilbur Smith confirmed, "All we do is storethe cartons and process the requisitions. I'll tell you, the amountof warehouse space we need just depends on the number of cartons.If we got into some flexible lease programs and changed aisleconfigurations, we could probably adjust our space requirements ifthe number of cartons we stored was to change. The other thing thatbothers me is that we've got some inventory that's been sittinghere forever.

The team then interviewed warehouse supervisor, Rick Fosmire, "Idon't care if I get a hundred requisitions with one line each orone requisition with a hundred lines on it, my guys still have togo pick a hundred items off the shelves. And those darned"pick-pack" requests. Almost everything is "pick-pack" nowadays. Noone seems to order a whole carton of 500 items anymore. Do you knowhow much more labor it requires to pick through those cartons? Andon top of that, this desk top delivery is a time drain for my guys.It's not like my guys don't have enough to do."

John and Tim returned to Denver with a better idea of whathappens in a distribution center. From what they observed, theybroke the distribution center down into 5 primary value-addedactivities: storage, requisition handling, basic warehouse stockselection, "pick-pack" activity, and desk top delivery.

They turned to Melissa for help assigning costs to activities.Melissa spent considerable time talking to each of the sitemanagers and warehouse supervisors. A consistent picture emerged.The majority (85%) of facility costs related to storage of businessforms. The remainder (15%) was necessary to handle theadministration of requisition processing. Warehouse workers wereinterviewed to determine where they spent their time. The basicprocess of finding and selecting items required half of their time(50%) - this includes finding and selecting either full box ordersor âpick-packâ orders. If the order also required âpick-packâ thisnearly doubled the required time as the workers opened cartons,counted items, etc. Thus, workers estimated that they spent 40% oftheir time dealing with âpick-packâ over and above basic formsselection. Preparing and handling desk top delivery shipments tookup the rest of their time (10%). Based on the above information,Melissa assigned costs to these activities as follows ($'000's).(See Exhibit 3 for calculations):

Storage	$1,625
Requisition Handling	$2,147
Basic Warehouse Stock
Selection	$967
Pick-Pack Activity	$774
Desk Top Delivery	$194
Total	$5,707

Tim then estimated the following for 2004 based upon historicalinformation and current trends:

On average, the 10 distribution centers scattered across thecountry will have combined inventories of approximately 350,000cartons (most cartons were of standard size).

TFC will process about 310,000 requisitions for 2004.

Requisitions will average 2.5 lines of different stationerymaterial requested and pulled.

About 90% of the lines will require an additional "pick-pack"activity (as opposed to shipping an entire carton).

They were still uncomfortable with the way inventory financingand trucking costs were charged out. John checked with the financedepartment and learned that Western obtained financing at the primerate (currently 8%) plus 2%. He thought they could just pass thatalong. "Our new computer system is coming on line soon which willtrack mileage we log to deliver shipments to each customer," saidTim, "so, using a per mile cost we can just charge the client forwhat it actually costs us." They all agreed that this soundedfair.

They were almost finished. "What about desk top delivery?" Timsaid. I think we should charge extra for it, but I don't want thisto get too complicated."

John said, "How much extra time does it take your guys onaverage to prepare a desk top delivery and then run around thecustomerâs company?"

"I'd say about an hour and a half to two hours."

"Alright. At $12 per hour, that's about $24 each time.

"Sounds OK to me. That ties pretty well to the $194,000 overallassignment, since we will process somewhere around 8,500 'desk top'requests this year."

The above information was used to derive activity / cost drivers(See Exhibit 4).

The entire management team, including Doug Kingsley, FinanceDirector of the Business Forms Division, felt that there had to bea better way of charging out distribution services and that thesolution would help TFC become more profitable. They now had a muchbetter understanding of the drivers of costs involved indistribution services. As the four headed off in Doug's SUV for theBroncosâ first home game, they tried to figure out how to use thisinformation to find a workable alternative.

SERVICES BASED PRICING (SBP)

"It would not be easy getting the sales force on board with anactivityâbased pricing program," John said. "Some of them getpretty stuck in their ways and don't like change. Some accountswould see increases because of the additional distribution chargesunder a Services Based Pricing (SBP) scheme. These salespeoplewouldn't be very happy. On the other hand, some salespeople may seetheir margins increase." Overcoming these organizational problemswould be only the tip of the iceberg.

Kingsley, as well as many of the senior managers at corporate,continued to be very concerned with TFC profitability. Whileeveryone thought TFC now had a better understanding of its costdrivers, they were not convinced that overall profitability wouldimprove without significant changes in marketing. They were stillwondering how to use their new activity based costing (ABC)analysis to improve the profitability of TFC. So they decided to doadditional analysis on their customer base.

The accounting department had maintained a database, whichshowed all activity against individual accounts and calculated acontribution from that account. Although TFC maintained 1100separate accounts, a large portion of the business came from veryfew accounts. The top 40 accounts represented 48% of the company'snet sales volume (see Exhibit 5).

As a way of understanding customer profitability, TFC managementreworked the information in the database as if the accounts hadbeen charged service fees based on actual usage, leaving net salesand product cost the same as before. They recalculated contributionbased on these figures. They ranked the accounts according toprofit contribution. Exhibit 6 shows the top 20 accounts for themonth of August and Exhibit 7 shows the bottom 20.

The team looked at all accounts where the revised contributionwas below 20% and determined that if these accounts were managed toa 20% contribution, the profit improvement would be $4.3 millionannually. Of those, the top 40 accounts (ranked by the contributionopportunity if improved to a 20% contribution) represented 70% ofthe $4.3 million opportunity.

Another way of summarizing the range of profitability across the1,100 customers is shown in Exhibit 8. This was a new way oflooking at account management which combined the effects of bothvolume and contribution margin. Since such a large piece of theopportunity rested with these few accounts, management determinedthat it might be possible to significantly improve profitability byconcentrating on individual account management. The team felt theywere on the right track for improving account profitability andwondered what should be the next step. They also wondered whatother issues might be important for improving the overallprofitability of TFC. Management called the ABC based pricingsystem SBP and was seriously considering adopting it for all TFCcustomers.

Case Questions to Consider

How did Total Forms Control (TFC) fit into Westernâs strategy?Was it performing up to expectations?

How did the existing accounting system handle the costs ofservices that TFC provided? Did this suit TFCâs needs?

Using the information in the case calculate ABC based servicescosts per unit of activity for the TFC business. Using these newactivity costs calculate distribution services and gross profit forcustomer A and customer B. What inferences do you draw about theprofitability of these two customers?

What does TFCâs analysis of individual customer accounts(exhibits 5-8) suggest about TFCâs overall customer profitability?What might managers do based on this information?

What are likely to be some of the issues in adopting ServiceBased Pricing (menu) pricing? Do you think that TFC shouldimplement the SBP pricing system?

Do you have any additional comments or recommendationsconcerning the Total Forms Control (TFC) business?

EXHIBIT 1
Calculation of Service Fee Charges
(Current Method)
('000's)
2002 Product Sales at Cost		$24,059
2002 Warehousing/Distribution Expense		$4,932
	...% of Product Cost	20.5%
2002 Average Inventory Balance		$10,873
2002 Average Cost of Capital		10.40%
Total Cost of Inventory Financing		$1,131
	...% Product Cost	4.70%
2002 Total Truck Operating Costs		$1,684
	...% Product Cost	7.00%

EXHIBIT 2
Actual Service Fee Charges
(Current Method)
	Customer A	Customer B
Product Cost	50000	50000
Warehousing/Distribution (20.5%)	10250	10250
Inventory Financing (4.7%)	2350	2350
Trucking (7%)	3500	3500
Total Service Fees	16100	16100
Markâup (20%)	13220	13220
Net Sales	79320	79320

EXHIBIT 3
Breakdown of Expenses by Activity
('000's)
	Total Expenses	Share of Expenses
Storage
Rent	$1,504x 85%	$1,278
Depreciation	$208 x 85%	$177
Utilities	$200 x 85%	$170
Total		$1,625

Requisition Handling
Rent	$1,504 x 15%	$226
Depreciation	$208 x 15%	$31
Utilities	$200 x 15%	$30
Salaries + Fringes	$1,109	$1,109
Taxes/Insurance	$110	$110
Postage & supplies	$96	$96
Hourly Payroll + Fringes	$545	$545
Total		$2,147

Warehouse Activities
Variable Warehouse Pay + Fringes	$1,935	$1,935

Basic Warehouse Stock Selection (50%)		$967
"Pick-Pack" Activity (40%)		$774
Desk Top Delivery (10%)		$194
Total		$1,935

EXHIBIT 4
TFC Activities and Cost Drivers
Activities / Cost Driver		Cost Driver in units
Storage / Cartons in inventory	(cartons)	350,000
Requisition handling / Requisitions	(requisitioning)	310,000
Basic Warehouse Stock Selection / Carton lines	(carton lines)	775,000
"Pick-Pack" / âPick-Packâ lines	(Pick-Pack" lines)	700,000
Desk Top delivery / Desk Top deliveries	(Desk Top deliveries)	8500
Inventory financing / Inventory value		Not available or given elsewhere
Trucking / Mileage		Not available or given elsewhere

EXHIBIT 5
TFC Net Sales, 2003
Annual	No. of	% of TFC
Sales/Account	Accounts	Net Sales
>$300,000	40	48%
>$150,000	53	19%
>$75,000	86	15%
>$30,000	143	11%
>$O	778	7%
Total	1100	100%

EXHIBIT 6
Top 20 TFC Accounts for August, 2004
(Ranked by Contribution $)
Account	Actual Net Sales	Product Cost	ABC Based Service Costs	Revised Contribution

1	76,904	49,620	2,862	24,422
2	130,582	74,396	34,578	21,608
3	72,956	48,216	3,456	21,284
4	64,903	37,981	6,574	20,348
5	45,088	26,098	1,309	17,681
6	104,689	62,340	25,356	16,993
7	52,890	32,083	4,386	16,421
8	38,902	23,087	1,245	14,570
9	87,130	54,923	17,685	14,522
10	67,935	42,012	12,290	13,633
11	58,290	32,074	12,834	13,382
12	84,589	54,023	17,528	13,038
13	36,587	22,657	1,345	12,585
14	47,890	32,'545	3,657	11,688
15	56,294	27,801	16,923	11,570
16	61,056	38,924	11,034	11,098
17	56,902	32,789	13,904	10,209
18	45,893	29,570	6,904	9,419
19	62,954	41,034	13,746	8,174
20	26,699	16,830	2,236	7,633
Total	1,279,133	779,003	209,852	290,278

EXHIBIT 7
Bottom 20 TFC Accounts for August, 2004
(Ranked by Contribution $)
Account	Actual Net Sales	Product Cost	ABC Based Service Costs	Revised Contribution
1081	3,657	2,356	2,325	â1,024
1082	38,467	26,301	13,740	â1,574
1083	5,926	3,840	4,214	â2,128
1084	163	89	2,390	â2,316
1085	3,256	2,006	3,590	â2,340
1086	82,086	61,224	23,756	â2,894
1087	29,320	20,647	11,843	â3,170
1088	467	302	4,086	â3,921
1089	17,935	11,087	10,872	â4,024
1090	17,649	12,903	8,903	â4,157
1091	638	420	5,109	â4,891
1092	16,104	9,102	12,134	â5,132
1093	289	178	5,698	â5,587
1094	23,965	17,345	16,523	â9,903
1095	38,065	23,391	27,623	â12,949
1096	32,898	23,054	22,985	â13,141
1097	129,367	73,128	69,527	â13,288
1098	74,569	50,745	45,698	â21,874
1099	88,345	64,930	53,867	â30,452
1100	113,976	82,987	72,589	â41,600
Total	717,142	486,035	417,472	â186,365

Exhibit 8

Current Operation Profit for 2004

The most profitable 5% of customers (55) contribute 80%

The next most profitable 45% of customers (145) contribute 220%.Profit could be 300% of the current level if we dropped theremaining 50% of customers (550)!

48% of customers (528) reduce profit by 140%.

2% of customers (22) reduce profit by 60%.

DISCUSSION QUESTIONS:

Discuss the following concepts only in the context of thisproblem.

1. Alternative Cost Driver Classification Schemes

2. ABC Implementation Issues

3. ABC and Customer Profitability Analysis

4. Activity Based Management

blueraccoon631

ACCT 1201 Lecture Notes - Dow Jones Industrial Average, Fortune Global 500, Online Banking

Document Summary

Get access

Related Documents

HONR 1101 Study Guide - Dow Jones Industrial Average, Fortune Global 500, Online Banking

BUS 10123 Lecture Notes - Lecture 14: Online Banking, Investing Online, Financial Services

FIN 3636 Chapter : Chapter 3 Notes

Related Questions